The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to educate individual investors about high-yield corporate bonds, also called “junk bonds.” While they generally offer a higher yield than investment-grade bonds, high-yield bonds also carry a higher risk of default.
What is a high-yield corporate bond? A high-yield corporate bond is a type of corporate bond that offers a higher rate of interest because of its higher risk of default.
When companies with a greater estimated default risk issue bonds, they may be unable to obtain an investment-grade bond credit rating.
As a result, they typically issue bonds with higher interest rates in order to entice investors and compensate them for this higher risk. High-yield bond issuers may be companies characterized as highly leveraged or those experiencing financial difficulties.
Smaller or emerging companies may also have to issue high-yield bonds to offset unproven operating histories or because their financial plans may be considered speculative or risky.
What are some key risks in high-yield corporate bonds? some investors with a greater risk tolerance may find high-yield corporate bonds attractive, particularly in low interest rate environments. If you are considering buying a high-yield bond, it is important that you understand the risks involved. Default risk. Also referred to as credit risk, this is the risk that a company will fail to make timely interest or principal payments and default on its bond. Defaults also can occur if the company fails to meet certain terms of its debt agreement. Because high-yield bonds are typically issued by companies with higher risks of default, this risk is particularly important to consider when investing in high-yield bonds.
Interest rate risk. Market interest rates have a major impact on bond investments. The price of a bond moves in the opposite direction than market interest rates—like opposing ends of a seesaw. This presents investors with interest rate risk, which is common to all bonds
. In addition, the longer the bond’s maturity, the more time there is for rates to change and, as a result, affect the price of the bond. Therefore, bonds with longer maturities generally present greater interest rate risk than bonds of similar credit quality that have shorter maturities.